## CANADA — Financial System Stability Assessment—Update

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### Executive Summary
- Canadian financial sector among the world’s most highly developed, with sophisticated institutions, markets, infrastructure, safety nets, and oversight arrangements covering a full range of financial intermediaries.
- Financial and capital markets trade a broad range of equity, debt, and derivative instruments in material volumes, supported by modern clearing and settlement systems.
- Authorities implemented the principal recommendations of the 2000 FSAP.
- Five large banking groups form the core of the system; conservatively managed, highly profitable, with strong risk-based capital ratios, modest returns on assets, and high returns on equity.
- “Widely held” rule limits concentration of bank share ownership and scope for mergers and foreign entry through acquisition; banks focus on profitable domestic retail franchises and retail strategies abroad, mainly in the United States and the Americas.
- Stress tests indicate large Canadian banks can withstand a broad range of shocks; in the main stress scenario entailing a severe recession, capital for some banks drops below the regulatory minimum but remains adequate.
- Global financial turmoil since mid-2007 highlighted information and liquidity risks in structured finance products embraced by Canadian banks; writedowns are beginning.
- Canadian nonbank-sponsored ABCP market affected by global credit market turbulence; authorities encouraged a market-led restructuring of the C$ 35 billion of nonbank-sponsored ABCP, and an agreement in principle has been reached.
- Regulators consider potential capital charges and writedowns from consolidating conduits on balance sheet manageable.
- Focused review of Basel Core Principles found OSFI compliant with the four revised principles reviewed; supervision is reliance-based and may require additional resources for cross-checking banks’ submissions, including on-site.
- Securities regulation largely implements IOSCO Principles; gaps remain in regulation and supervision of collective investment schemes and in enforcement.
- Creation of the Canadian Securities Administrators (CSA) and the passport system improved coordination; staff see merit in moving beyond a passport toward a single securities regulator to streamline policy development, reduce costs, and improve enforcement.
- Canadian Depository Securities Settlement System complies with almost all RSSS; recommendations focus on enhancing risk management procedures and the regulatory environment.

### Key findings and systemic issues
- Stress tests and analysis:
  - Main stress scenario assumes a recession one-third larger than in 1990–91.
  - Under the main scenario capital for some banks falls below the regulatory minimum but remains adequate.
  - Banks appear able to withstand specific large single-factor shocks for credit, market, and liquidity risk.
- Structured finance and ABCP:
  - ABCP market disruption centers on C$ 35 billion of nonbank-sponsored ABCP.
  - Market-led restructuring encouraged; agreement in principle reached.
  - Reduced money-market liquidity poses significant risk of spillovers to financial institutions.
- Regulatory and supervisory posture:
  - OSFI’s reliance-based supervision reduces duplication and controls regulatory costs but may need additional resources for supervisory cross-checking and on-site work.
  - Securities regulation is provincially based; implementation of National Instrument 31–103 would address many gaps for collective investment schemes, but enforcement needs strengthening.
  - Moving toward a single securities regulator would streamline policy, likely reduce costs, and improve enforcement.
- Payment, clearing, and settlement:
  - Depository securities settlement system sound, efficient, and reliable, with solid legal basis and appropriate procedures to mitigate credit, liquidity and operational risks.

### Main recommendations
- High priority:
  - Carefully monitor and manage fallout from turmoil in global money and credit markets, given problems in the Canadian nonbank-sponsored ABCP market; relevant authorities should regularly review possible measures in view of emerging information.
  - Encourage market participants to increase transparency of conduits and other structured finance products, supported by reliable ratings; authorities should ensure market participants continue to move in this direction.
  - OSFI should consider allocating additional resources for cross-checking financial institutions’ submissions, including on-site inspections, to assess risk in a complex and evolving environment.
- Medium priority:
  - BoC may wish to regularly conduct stress tests as an input for its Financial System Review; desirable to develop a system-wide approach in cooperation with OSFI.
  - Increase transparency and reduce room for discretion and forbearance in bank intervention and resolution; the “structured early intervention” regime provides but does not mandate specific supervisory actions and the Minister may waive certain CDIC interventions for public interest reasons.
  - Move beyond a passport system towards a single securities regulator to streamline policy, reduce costs, and improve enforcement.
- Lower priority:
  - CDS could assess benefits and costs of acting as a CCP for trade-for-trade (TFT) transactions.
  - Consider introducing a securities lending facility to reduce settlement failure; separate CCP functions from CDS functions; reduce concentration of settlement cash for U.S. dollar-denominated securities in a single settlement bank.
  - OSFI and the provinces should ensure regulatory framework for pension funds increasingly focuses on adequacy of risk management practices and resources, in addition to solvency.

### Bank soundness and stress testing — detailed results
- Stress-test design:
  - Principal macro stress (MS) scenario: ten quarters, developed using BoC macroeconomic model; bottom-up (BU) tests performed by the five largest banks; consistency tests (CT) cross-check BU results; five single-factor (SF) shocks also considered.
- BU MS results — Capital Adequacy Ratio (In percent; columns: period / Expected Loss / Unexpected Loss / CAR):
  - 2006Q4 0.87 2.83 8.88
  - 2007Q1 0.88 2.90 8.80
  - 2007Q2 0.77 2.77 9.04
  - 2007Q3 0.92 3.55 8.11
  - 2007Q4 1.03 3.95 7.60
  - 2008Q1 1.15 4.30 7.13
  - 2008Q2 1.43 4.88 6.27
  - 2008Q3 1.60 5.23 5.75
  - 2008Q4 1.73 5.45 5.40
  - 2009Q1 1.85 5.63 5.10
- CT MS results — Capital Adequacy Ratio (In percent; columns: period / Expected Loss / Unexpected Loss / CAR):
  - 2006Q4 0.31 4.16 8.11
  - 2007Q1 0.26 3.80 8.52
  - 2007Q2 0.24 3.84 8.50
  - 2007Q3 0.32 4.12 8.14
  - 2007Q4 0.41 4.25 7.92
  - 2008Q1 0.55 4.42 7.61
  - 2008Q2 0.93 4.99 6.66
  - 2008Q3 1.24 5.22 6.12
  - 2008Q4 1.48 5.38 5.72
  - 2009Q1 1.68 5.67 5.23
- Interpretation:
  - MS results show minimum CAR of 8 percent breached from the fifth quarter on for some banks; despite breaches "all banks continue to have adequate capital" thanks to comfortable initial capitalization (note: initial buffer calculated as CAR plus additional loss buffer for the big five banks in 2006Q4 (12.59 percent), less EL and UL).
- Single factor shocks — BU impact on CAR (percentage points relative to baseline CAR):
  - SF1 (real estate prices) CAR -4.02
  - SF2 (U.S. recession and political risk in Latin America) CAR -3.55
  - SF4 (inversion of the yield curve) CAR -0.77
  - SF5a (parallel up 350 bps) CAR -0.84
  - SF5b (parallel down 350 bps) CAR 0.13
- Liquidity stress test:
  - All banks reported expected survival horizon would be more than one year under the designed liquidity shock.
  - Qualification: stress-test assumptions excluded systemic constraints on selling liquid assets and functioning money markets; real market conditions already showed reluctance to lend and higher short-term liquidity costs.

### ABCP, structured finance, and market turmoil
- Canadian securitization dominated by short-term ABCP; about one-third of ABCP market shut down since August 2007.
- ABS outstanding as of June 30, 2007: $180 billion, of which $116 billion was ABCP.
- Third-party arbitrage-oriented conduits accounted for about C$ 35 billion of the C$ 116 billion outstanding just prior to the August shutdown; these conduits particularly exposed to CDOs backed by U.S. subprime mortgages.
- Prior to August 21, only multi-seller conduits sponsored by two banks offered global-style protection ($11 billion and $7 billion outstanding, respectively).
- August 21 and 22: banks sponsoring some C$ 86 billion of ABCP announced they would offer unconditional "global style" liquidity protection.
- DBRS changed its ABCP rating criteria on September 13 to require global-style liquidity support.
- The "Montréal Proposal" proposed converting short-term securities into floating-rate notes with maturities linked to conduits’ underlying assets (up to 10 years); by mid-December only one conduit had been converted; on December 23 an agreement in principle was reached to convert all but one conduit by March.
- OSFI stress tests indicate banks putting assets from sponsored conduits on-balance-sheet would remain with capital above regulatory targets, though tests may not consider interruption of financing, asset price declines, or costs of holding "bridge loans."
- ABCP represented about half of the outstandings in the corporate short-term paper market: of C$ 223 billion short-term corporate paper outstanding on August 31, 2007, C$ 115 billion was ABCP, C$ 58 billion bankers’ acceptances, and C$ 50 billion direct corporate issuance. Of the C$ 115 billion ABCP, C$ 32 billion was issued by the "Montreal Proposal" conduits.

### Observed financial soundness metrics and market-based measures
- Aggregate CAR of the five largest banks declined to 11.8 percent, from 12.4 percent in the fourth quarter of 2006.
- Earnings remained high and stable through the third quarter of 2007.
- At least one major bank expects substantial writedowns from exposures to U.S. subprime assets, amounting to perhaps one fifth of its capital and one quarter of its earnings over the last year; it decided to raise additional capital through a common share issue.
- Market-implied two-year PoD of a single Canadian bank (Moody’s KMV) increased to about 7 percent in mid-December, compared with 2 percent before market turbulence, and remains well below the 14 percent seen in the United States.
- Banking Stability Index (BSI), defined via joint PoD of largest banks, increased commensurately.

### Crisis management, liquidity facilities, and deposit insurance
- Financial safety net and crisis-management framework well designed; FISC coordinates interagency decision-making (Governor of BoC, Deputy Minister of Finance, heads of OSFI, CDIC, and Financial Consumer Agency of Canada).
- Deposit insurance:
  - CDIC main provider; membership open to most chartered depositories; risk-based premiums; full coverage for deposits up to C$ 100,000 per individual depositor per member institution.
  - CDIC financial resources and authorities: C$ 1.6 billion contingency fund; standing authority to borrow up to C$ 6 billion; may apply for special appropriations.
- Bank of Canada liquidity facilities:
  - SLF: routine overnight credit at the Bank Rate (set at 25 basis points over the overnight rate) to participants in LVTS.
  - ELA: credit at or above the Bank Rate for up to six months, renewable at BoC discretion, to solvent depositories experiencing liquidity strains.
  - Facility to provide liquidity to any financial or nonfinancial firm via outright purchases upon a finding of “severe and unusual stress on a financial market or financial system.”
  - SLF eligible collateral list expanded in December 2007 to include certain types of ABCP sponsored by banks and U.S. Treasuries; further broadening expected in March 2008.
  - BoC uses private credit ratings to determine eligibility of, and haircuts on, privately issued collateral for SLF.

### Payment, clearing, and settlement — CDSX and market infrastructure
- CDSX introduced in 2003; as of end-2006:
  - securities held in custody averaged C$ 3 trillion;
  - average daily value of all transactions settled in CDSX totaled C$ 230 billion;
  - average number of daily transactions was 405,800.
- CDS had 100 participants in 2006, including domestic and foreign financial institutions, the BoC, some government enterprises, and the Canadian Derivatives Clearing Corporation.
- Cross-border services: New York Link and DTC Direct Link with DTC in the United States; CDS uses commercial banks to settle cash leg of U.S. dollar-denominated cross-border transactions.
- Legal framework: federal Payment Clearing and Settlement Act (1996, amended 2007) provides legal protection to settlement rules/netting and empowers BoC to designate and oversee systems with systemic risk potential.
- Key operational and risk observations:
  - CDS acts as CCP for cash payments arising from securities transactions settled in CDSX and as CCP on the securities leg of net-settlement transactions; novation typically occurs at settlement date (participants face counterparty risk until novation, up to T+3).
  - Settlement cycles: equities T+3; debt instruments T+0, T+2, or T+3 depending on instrument; all trades between direct market participants confirmed same day.
  - Intraday negative funds balances permitted at CDSX; credit positions managed via standby lines, collateral pools, and novation.
  - For U.S. dollar-denominated securities cash settlement, CDS currently uses a single bank — recommended to reduce concentration or seek access to FedWire or U.S. dollar central bank money via BoC.
  - Recommendation that CCP functions be legally separated from settlement/custody functions to protect CDSX from CCP credit and liquidity risks.
  - CDS should not allow transfer of securities delivered through DTC links to participants until those securities reach settlement finality in DTC system (recommendation due to potential credit exposure).
  - CDS encouraged to consider securities lending facility to reduce settlement failure and to dematerialize securities to reduce custody risk.
- Governance, transparency, and oversight:
  - CDS owned by users; board reflects shareholders, users, and public interest; rules and major decisions published.
  - BoC oversees CDSX at federal level; OSC and AMF have provincial regulatory responsibility for CDS as clearing house and depository; cooperation among authorities is informal and ad-hoc.
  - Suggested formalization of cooperative arrangements between BoC and securities regulators and with relevant U.S. authorities for cross-border oversight.

### Securities regulation — structure, IOSCO assessment, and reform options
- Securities laws remain provincial, resulting in fragmentation across 13 regulatory authorities; Ontario and Quebec frameworks used to infer national implementation due to harmonization via National Instruments.
- IOSCO assessment: high degree of implementation of IOSCO Principles in largest provinces; gaps in collective investment scheme (CIS) operator registration and enforcement.
- Collective investment schemes:
  - CIS operators not subject to registration regime under current framework; proposed National Instrument 31–103 Registration Requirements would address gaps.
  - Not all CIS required to have custodian; proposed National Instrument 41–101 would extend custodian requirement.
- Passport system:
  - Being implemented by 12 provinces (all except Ontario); under passport, participants deal only with home-jurisdiction regulator and decisions apply automatically elsewhere; OSC retains opt-out authority.
  - Passport improves registration but does not address fee multiplicity, policy development delays, or fragmented enforcement.
- Single regulator:
  - Staff view: single regulator or "common regulator" could reduce compliance costs, streamline policy development, and improve enforcement; majority of submissions (74 percent of 77 submissions) recommended a single regulator.
- Enforcement:
  - Improvements in recent years but further strengthening needed, particularly criminal enforcement coordination and retention of qualified personnel.
- SROs and market intermediaries:
  - SROs (IDA, MFDA, RS, MX, CSF) play significant oversight roles; authorization, on-site inspection cycles (~three years), and oversight coordination recommended to be strengthened.
- TSX and market statistics:
  - At end-2006, TSX domestic market capitalization C$1.98 trillion; TSX Group market capitalization US$1,701 billion (December 2006), ranking 7th by market capitalization and 12th by trading value (US$1,282 billion for 2006).
  - In 2006 there were 195 interlisted issuers out of 1,598 TSX-listed issuers, combined market value US$1.2 trillion or 61 percent of total domestic market.

### Pension funds, retirement savings, and related risks
- Retirement system three pillars:
  - First pillar: Old Age Security/Guaranteed Income Supplement (Government of Canada financed).
  - Second pillar: Canada Pension Plan (mandatory employee and employer contributions); sustainable at current contribution rates until at least 2075.
  - Quebec Pension Plan serves Quebec residents and is similar to CPP.
  - Two public pillars provide replacement rate of approximately 70 percent.
  - Third pillar: registered pension plans and individual registered retirement savings plans; these plans now provide more than 30 percent of retirement income.
- Pension funds diversifying into global and complex asset classes (hedge funds, private equity, infrastructure) due to decline in government bond market size and increased M&A activity.
- Regulatory recommendation: increase focus on adequacy of risk management practices and resources in addition to solvency; consider encouraging larger multi-employer plans, facilitating (re)insurance for extreme risks, or affiliation/outsourcing to sophisticated money managers.

### Authorities’ responses and implementation considerations
- Authorities largely agree with IOSCO assessment findings; adoption of National Instrument NI 31-103 and NI 41-101 expected to address CIS registration and custodian gaps.
- CDS and regulators acknowledged recommendations on CCP legal separation, U.S. dollar settlement concentration, and cross-border oversight; partial responses include consideration of contracting a second U.S. dollar settlement bank and ongoing discussions to formalize cooperation (e.g., regular meetings among BoC, OSC, AMF).

*Prepared by the Monetary and Capital Markets Department; approved January 15, 2008. Source: IMF staff report excerpt (content unit _cr0859).*

### 2008. The views expressed in this document are those of the staff team and do not necessarily reflect

### CANADA — Financial System Stability Assessment—Update

### Executive Summary
- The Canadian financial sector is among the world’s most highly developed, with sophisticated institutions, markets, infrastructure, safety nets, and oversight arrangements covering a full range of financial intermediaries.
- Canadian financial and capital markets trade a broad range of equity, debt, and derivative instruments in material volumes, supported by modern clearing and settlement systems.
- The authorities have implemented the principal recommendations of the 2000 Financial Sector Assessment Program (FSAP).
- The five large banking groups that form the core of the system are conservatively managed and highly profitable, with strong risk-based capital ratios, modest returns on assets, and high returns on equity.
- The “widely held” rule for large banks limits concentration of bank share ownership and thus scope for mergers and for foreign entry through acquisition; banks have focused on profitable domestic retail franchises and retail strategies abroad, mainly in the United States and the Americas.
- Stress tests indicate that large Canadian banks can withstand a broad range of shocks; in the main stress scenario entailing a severe recession, capital for some banks drops below the regulatory minimum but remains adequate.
- Credit risk remains central; the global financial turmoil since mid-2007 has highlighted information and liquidity risks embedded in structured finance products embraced by Canadian banks, and writedowns are beginning.
- Vulnerabilities may arise from banks’ attempts to enter highly competitive foreign markets or complex activities.
- The Canadian nonbank-sponsored asset-backed commercial paper (ABCP) market has been affected by global credit market turbulence; the authorities encouraged a market-led restructuring of the C$ 35 billion of nonbank-sponsored ABCP, and an agreement in principle has been reached.
- Banks may need to consolidate their conduits on balance sheet with attendant capital charges and writedowns, which regulators consider manageable.
- Greater transparency in conduits and structured finance products, supported by reliable ratings, will be necessary; authorities should ensure market participants continue to move in this direction.
- The focused review of the Basel Core Principles (BCP) found the Office of the Superintendent of Financial Institutions (OSFI) compliant with the four revised principles; bank supervision is reliance-based but may require additional resources for cross-checking banks’ submissions, including on-site.
- The regulatory framework for securities markets largely implements IOSCO Principles; gaps remain in regulation and supervision of collective investment schemes and in enforcement.
- The creation of the Canadian Securities Administrators (CSA) and the passport system has brought significant improvements; staff see merit in moving beyond a passport system toward a single securities regulator to streamline policy development, reduce costs, and improve enforcement.
- The Canadian Depository Securities Settlement System complies with almost all Recommendations for Securities Settlement Systems (RSSS); recommendations focus on further enhancing risk management procedures and the regulatory environment.

### Key Findings and Systemic Issues
- Stress tests and analysis:
  - Main stress scenario assumes a recession one-third larger than in 1990–91.
  - Under the main scenario capital for some banks falls below the regulatory minimum but remains adequate.
  - Banks appear able to withstand specific large single-factor shocks for credit, market, and liquidity risk.
- Structured finance and ABCP:
  - The CBCP market disruption centers on C$ 35 billion of nonbank-sponsored ABCP.
  - Market-led restructuring has been encouraged; an agreement in principle has been reached.
  - Reduced money-market liquidity poses significant risk of spillovers to financial institutions.
- Regulatory and supervisory posture:
  - OSFI’s reliance-based supervision reduces duplication and controls regulatory costs but may need additional resources for supervisory cross-checking and on-site work.
  - Securities regulation is provincially based; implementation of National Instrument 31–103 would address many gaps for collective investment schemes, but enforcement needs strengthening.
  - Moving toward a single securities regulator would streamline policy development, likely reduce costs, and improve enforcement; a single regulator could be structured in different ways, including the “common” regulator recommended by the Crawford Panel.
- Payment, clearing, and settlement:
  - The depository securities settlement system is sound, efficient, and reliable, with a solid legal basis, appropriate procedures to mitigate credit, liquidity and operational risks, and effective governance.

### Main Recommendations
High priority
- Carefully monitor and manage fallout from turmoil in global money and credit markets, given problems in the Canadian nonbank-sponsored ABCP market; relevant authorities should regularly review possible measures in view of emerging information.
- Encourage market participants to increase transparency of conduits and other structured finance products, supported by reliable ratings; authorities should ensure market participants continue to move in this direction.
- OSFI should consider allocating additional resources for cross-checking financial institutions’ submissions, including on-site inspections, to assess risk in a complex and evolving environment.

Medium priority
- The Bank of Canada (BoC) may wish to regularly conduct stress tests as an input for its Financial System Review; there is already close cooperation on financial stability analysis between OSFI and BoC and it would be desirable to develop a system-wide approach.
- Increase transparency and reduce room for discretion and forbearance in bank intervention and resolution; currently the “structured early intervention” regime provides but does not mandate specific supervisory actions as capital thresholds are breached, and the Minister may not approve certain CDIC interventions for public interest reasons.
- Move beyond a passport system towards a single securities regulator to streamline policy, reduce costs, and improve enforcement.

Lower priority
- Clearing and Depository Services (CDS) could assess benefits and costs of acting as a central counterparty (CCP) for trade-for-trade (TFT) transactions.
- Consider introducing a securities lending facility to reduce settlement failure; separate CCP functions from CDS functions; reduce concentration of settlement cash for U.S. dollar-denominated securities in a single settlement bank.
- OSFI and the provinces should ensure the regulatory framework for pension funds increasingly focuses on adequacy of risk management practices and resources, in addition to solvency.

### Supervisory Assessments and Institutional Observations
- FSAP design and scope:
  - FSAPs assess financial system stability as a whole, not individual institutions; they help identify structural weaknesses and enhance resilience to macroeconomic shocks and cross-border contagion.
  - FSAPs do not cover institution-specific risks such as asset quality, operational or legal risks, or fraud.
- Focused review of Basel Core Principles:
  - OSFI found compliant with the four revised BCPs reviewed.
  - Supervision is reliance-based, implying reduced duplication but a potential need for more supervisory cross-checking resources.
- Securities regulation:
  - Most provinces have robust legal and institutional frameworks; assessment relies largely on Ontario and Quebec frameworks.
  - Gaps in regulation and supervision of collective investment schemes remain, to be addressed significantly by National Instrument 31–103.
  - Enforcement of securities laws needs improvement; coordination among provincial regulators could be enhanced.
- Crisis management and liquidity:
  - Deposit insurance and arrangements for crisis management and failure resolution are well-designed.
  - Liquidity strains from global turmoil pose unusual challenges; banks may need to bring conduits on-balance-sheet with capital implications.

### Operational and Market Infrastructure
- Canadian market infrastructure supports trading in equities, debt, and derivatives with modern clearing and settlement.
- The clearing and settlement system’s legal basis and governance are strong; recommendations target enhancements to risk management procedures and regulatory oversight.

*Prepared by the Monetary and Capital Markets Department; approved January 15, 2008.*

### 1.      Canada’s institutional strength and robust framework for macroeconomic

### Canada’s institutional strength and robust framework for macroeconomic

### Overview and recent macroeconomic performance
- Real GDP has expanded by over 3 percent per year on average over the past decade.
- Inflation targeting has anchored expectations and kept inflation close to the 2 percent target.
- Canada’s federal government has recorded ten annual surpluses in a row.
- Sustained current account surpluses have improved the net international investment position over the last decade.
- The large commodity sector and the high share of exports to the United States expose Canada to a few closely related external shocks.

### Near-term outlook and risks
- Anticipated slowdown in the United States and the recent strength of the Canadian dollar will dampen net exports.
- Financial turmoil may curtail credit availability and crimp domestic demand.
- Real GDP growth is expected to slow to 2 percent on average in 2008, with risks skewed to the downside.

### Structure of the financial system — overview
- Canada has a highly developed financial system, dominated by a handful of full-service banks.
- Banks represent a limited source of long-term funding or more sophisticated financial products; their investment arms play a role in securing funding for large Canadian corporations through capital markets.
- With few barriers between financial sub-sectors, banking groups are dominant in nondeposit-taking business lines, such as mutual funds.
- Equity financing represents 38 percent of long-term business credit, and bond financing 34 percent.
- Life insurance accounts for about 9 percent of total financial assets and mutual funds for about 16 percent.

### Banks — market structure and concentration
- Banks represent about 60 percent of total financial system assets.
- The “big five” (Royal Bank of Canada, TD Canada Trust, Bank of Nova Scotia, Bank of Montreal, and Canadian Imperial Bank of Commerce) hold more than 85 percent of total bank assets.
- Foreign banks’ presence is less than 10 percent of bank assets.
- Larger banks also lead securities underwriting, merchant banking, and asset management.
- The “widely held” rule for large banks limits concentration of bank share ownership and thus the scope for mergers and for foreign entry through acquisition.
- Oligopolistic market structure: available studies do not provide conclusive evidence of market abuse, but the ability to garner large profits in low-risk activities suggests scope for steps to increase competition; lifting the widely-held rule alone might increase concentration.

### Insurance sector
- The insurance industry is stable, profitable, and well-capitalized.
- The life and health (L&H) insurance sector is dominated by three large domestic groups (accounting for 84 percent of the assets at the end of 2006).
- Life insurers are increasingly global and earn more than 50 percent of their revenue outside Canada.
- P&C insurance is more fragmented, with an important role for foreign insurers and provincial-government-owned insurers.
- Capital ratios comfortably exceed regulatory targets.
- Investment practices: about 60 percent of assets held in investment grade bonds; geographic composition of assets roughly matches liabilities.
- Holdings of ABCP are minimal.
- Earnings have been high in both the L&H and P&C sectors in the last few years.

### Securities markets
- Total revenue in securities industry amounted to C$ 15.9 billion in 2006, up 17.8 percent over 2005.
- Operating profits rose by one-third in 2006.
- Mutual fund industry is highly developed; majority of assets held in tax-deferred registered savings accounts.
- Among the 10 largest mutual fund managers, four are part of large Canadian banking groups, and three are part of financial groups in the United States and United Kingdom.
- Declining government (and provincial) debt issuance has been more than offset by corporate bond issuance.
- At end-2006, the Toronto Stock Exchange (TSX) had a domestic market capitalization of C$1.98 trillion and ranked seventh among stock exchanges globally.
- Removal of the Foreign Property Rule (lifted in 2005) was the primary driver of the development of the “Maple bond” market.
- No high-yield bond market in Canada; domestic demand for high-yield bonds traditionally limited.

### Hedge funds
- Assets managed by domestic hedge funds are estimated at C$ 30 billion in early 2007, up from about C$ 4 billion in 2000.
- Hedge fund industry remains small by international standards; less than 10 percent of funds manage assets in excess of C$ 100 million.
- Canada-based hedge funds are primarily focused on long/short equity strategies.
- Investor protection is improving; a “comprehensive registration rule” has been proposed.

### Housing finance
- Canadian mortgage market is well-developed, with low default rates.
- Subprime loans account for less than 3 percent of outstanding mortgages.
- Only one-fifth of Canadian mortgages are securitized.
- Statutory requirement: all bank-held mortgages with loan-to-value ratios above 80 percent must be insured (these mortgages carry a zero risk weight for regulatory capital purposes).
- Typical amortization period is 25 years; 30 and 40 year terms are increasingly available, but contractual maturity usually does not exceed 5 or 10 years.
- Prepayment penalties and lack of interest deductibility reduce demand for longer-term mortgages.
- Prevalence of deposit financing makes banks reluctant to offer long maturities.

### Retirement savings
- Retirement income system consists of three pillars:
  - First pillar: Old Age Security/Guaranteed Income Supplement Program, financed by the Government of Canada.
  - Second pillar: Canada Pension Plan (mandatory employee and employer contributions); sustainable at current contribution rates until at least 2075.
  - Quebec Pension Plan serves residents of Quebec and is similar to the Canada Pension Plan.
- The two public pillars provide a replacement rate of approximately 70 percent.
- Third pillar: registered pension plans and individual registered retirement savings plans; these plans now provide more than 30 percent of retirement income.

### Derivatives markets
- Derivatives markets are well-developed and sophisticated, with wide range of contracts available on regulated markets or OTC.
- Derivatives activity has developed primarily in the OTC markets.
- Canadian firms and residents conduct energy and commodities business primarily in London and New York.
- Regulation in the Canadian electricity market limits hedging needs by end-users.
- The Montreal exchange (specializing in derivatives) is set to merge with the TSX in 2008.

### Financial stability — overall assessment
- Canada’s financial system appears stable, with a low risk of systemic problems.
- Stability supported by sound macroeconomic policies, a well-designed crisis management framework, and advanced prudential regulation and supervision.
- Global problems in money and credit markets beginning in August 2007 spilled over to the Canadian system, triggering illiquidity in a large segment of the market for ABCP.
- Banks are beginning to write down exposures to subprime assets; problems appear manageable thus far.

### Bank soundness and stress tests
- Stress tests indicate that the five largest banks would be capable of weathering a shock about one-third larger than the 1990–91 recession, involving a contraction of the North American economy, an increase in interest rate risk premia, and lower commodity prices.
- The banks’ position going into the stress tests:
  - Sum of loan loss provisions and capital (as a ratio of risk-weighted-assets) stood at 12½ percent at end 2006 (a slight decline from 13¾ percent at end 2003).
  - Nonperforming loan ratio declined from 1.2 percent to 0.4 percent during the same period.
- Stress-test methodology and scenarios:
  - Principal stress test based on a macroeconomic scenario (MS) covering ten quarters, developed using the BoC macroeconomic model to ensure internal consistency.
  - Bottom-up stress tests (BU) were performed by the five largest banks using their internal risk models.
  - BU results for the MS were cross-checked using consistency tests (CT), drawing on banking data provided by the authorities.
  - Risk-based methodology for CT allows estimation of expected losses (EL) and unexpected losses (UL) with publicly available information.
  - Five single factor shocks (SF) were also considered.

*Source: IMF staff report excerpt — “Canada’s institutional strength and robust framework for macroeconomic”*

### 20.      The results of the MS stress test for credit risk show that banks would experience

### 20.      The results of the MS stress test for credit risk show that banks would experience

### Main findings from the Macro Stress (MS) test on credit risk
- The MS stress test shows banks would experience significant capital stress in the unusually strong recession in the scenario, but "thanks to their comfortable initial capitalization, banks appear to be capable of weathering this storm."
- The cumulative effects of macroeconomic shocks propagate from increasing probabilities of default (PoD), to expected losses (EL) and unexpected losses (UL), and ultimately to banks’ capital adequacy ratios (CAR).
- "From the fifth quarter on, the minimum capital adequacy ratio (CAR) of 8 percent is breached, with some banks more seriously affected than others. Even so, all banks continue to have adequate capital."
- The Consistency Test (CT) closely confirms the Bottom Up (BU) results.
- Single factor shocks for credit risk have a less pronounced effect on CAR individually, but in combination are quite substantial.

### Box 1 — Macroeconomic stress scenario (narrative)
- Labor productivity growth sharply decreases in the United States, remaining weak for a long period of time.
- U.S. consumers and firms increase saving rates; foreigners’ concern about U.S. current account imbalances results in a significant depreciation of the U.S. dollar.
- The U.S. weakness and increased PoD lead to a rise in financial risk premia, further exacerbating the economic slowdown.
- Canadian consumers and firms lose confidence and increase savings; the Canada-United States exchange rate appreciates, contributing to a contraction of the Canadian economy.
- A rise in commercial interest rate premia further exacerbates weakness in Canadian GDP growth.

### Capital Adequacy Ratio under Macro Stress Scenario — BU and CT results (In percent)
- Bottom Up Stress Test (period / Expected Loss / Unexpected Loss / CAR):
  - 2006Q4 0.87 2.83 8.88
  - 2007Q1 0.88 2.90 8.80
  - 2007Q2 0.77 2.77 9.04
  - 2007Q3 0.92 3.55 8.11
  - 2007Q4 1.03 3.95 7.60
  - 2008Q1 1.15 4.30 7.13
  - 2008Q2 1.43 4.88 6.27
  - 2008Q3 1.60 5.23 5.75
  - 2008Q4 1.73 5.45 5.40
  - 2009Q1 1.85 5.63 5.10
- Consistency Test (period / Expected Loss / Unexpected Loss / CAR):
  - 2006Q4 0.31 4.16 8.11
  - 2007Q1 0.26 3.80 8.52
  - 2007Q2 0.24 3.84 8.50
  - 2007Q3 0.32 4.12 8.14
  - 2007Q4 0.41 4.25 7.92
  - 2008Q1 0.55 4.42 7.61
  - 2008Q2 0.93 4.99 6.66
  - 2008Q3 1.24 5.22 6.12
  - 2008Q4 1.48 5.38 5.72
  - 2009Q1 1.68 5.67 5.23
- Note: "Calculated as CAR plus additional loss buffer for the big five banks in 2006Q4 (12.59 percent), less EL and UL in each period."

### Single factor shocks (definitions and impacts)
- Single factor 1 — Credit risk: real estate prices.
  - Residential and commercial real estate prices decrease by 30 percent in Western Canada and by 15 percent in Central Canada.
- Single factor 2 — Credit risk: recession in the United States and political risk in Latin America.
  - GDP in the United States falls 1 percent for 1 year; Canadian bank holdings in Latin America are adversely affected by political risk.
- Single factor 3 — Liquidity risk.
  - Bank is shut out of the wholesale funding market due to a significant credit downgrade, resulting in an immediate 50 percent run-off in wholesale deposits and a 25 percent decline in consumer deposits over three months. (Shock not included in capital table because principal effect is not on capital.)
- Single factor 4 — Market risk: inversion of the yield curve.
  - Front moves up by 300 basis points (bps) and the back moves down by 25 bps.
- Single factors 5a, 5b — Market risk: parallel shifts of the yield curve.
  - Instantaneous parallel shift. Up by 350 bps, down by 350 bps.
- Capital Adequacy Ratio under Single Factor Shocks — Impact effect (relative to baseline CAR, in percentage points) — Bottom Up Stress Test:
  - SF1 CAR -4.02
  - SF2 CAR -3.55
  - SF4 CAR -0.77
  - SF5a CAR -0.84
  - SF5b CAR 0.13

### Model assumptions, caveats, and robustness issues
- The MS entails a recession "one-third deeper than in 1990–1991"; the BoC general equilibrium model includes a highly effective monetary policy response and a transmission mechanism that allows for a rapid recovery after the initial shock.
- The BoC model does not include financial accelerator effects; the increase in the commercial risk premium was treated as an exogenous shock.
- The PoD model estimated by the BoC was regarded by the FSAP team as understating the likely rise in defaults under the MS; an ad hoc adjustment was agreed.
- Models do not take account of second-round effects that severe shocks to the financial system could have on the macroeconomy, nor do they take account of portfolio adjustments, changes in profitability, or confidence effects.
- "Most loans in banks’ portfolios have flexible interest rates" (information indicates that on average, more than 50 percent of loan exposures have flexible interest rates).
- Market risk is relatively modest overall, but exposures vary significantly across institutions; interest rate shocks transmit primarily through credit risk because of flexible-rate loans.
- Banks dynamically hedge much of their investment book to maintain matched duration, though complexity and opacity of trading operations and increased exposure to illiquid credit derivatives in some large banks are concerns.

### Liquidity stress test and short-term funding environment
- The liquidity shock does not seem to affect banks’ capacity to maintain normal operations: "All the banks report that their 'expected survival horizon' would be more than one year."
- Qualification: current market conditions differ from stress-test assumptions (assumed no systemic constraints on selling liquid assets and functioning money markets). In practice, reluctance to lend among banks and higher short-term liquidity costs were already evident and not considered in the stress test design.

### Recommendations and lessons for authorities and BoC
- The BoC should regularly conduct system-wide stress tests as an input for its Financial System Review, building on close cooperation with OSFI.
- Stress-testing exercise highlighted data gaps for systemic stress testing (e.g., recovery rates and PoDs).
- Given its strong modeling capacity, the BoC would be well positioned to contribute to international efforts to model macro-financial interactions.

### Related findings on ABCP and market turmoil (section B highlights)
- Canadian securitization dominated by short-term ABCP; about one-third of ABCP market shut down since August 2007.
- About $180 billion of ABS outstanding as of June 30, 2007, of which $116 billion was ABCP.
- Third-party arbitrage-oriented conduits accounted for about C$ 35 billion of C$ 116 billion outstanding just prior to the August shutdown; they were particularly exposed to CDOs backed by U.S. subprime mortgages.
- Prior to August 21, only multi-seller conduits sponsored by two banks offered global-style protection ($11 billion and $7 billion outstanding, respectively).
- OSFI’s Regulation B-5 exempted only GMD-conditional liquidity support from bank regulatory capital requirements; differences in credit conversion factors (CCF) were noted across jurisdictions and Basel II rules:
  - For unconditional facilities up to one year, North America applied a 10 percent CCF (national discretion), most European countries applied a zero CCF.
  - Basel II will apply a zero CCF to GMD-conditional support, and 20 percent to unconditional facilities with maturities up to one year.
- Rating agencies initially diverged: Moody’s and S&P effectively refused to give high ratings to Canadian ABCP; DBRS gave most programs R-1 high.
- "The 'Montréal Proposal'... proposed to convert the short-term securities into floating-rate notes with maturities linked to those of the conduits’ underlying assets (up to 10 years)." By mid-December only one conduit had been converted; on December 23 an agreement in principle was reached to convert all but one conduit by March.
- On August 21 and 22, banks sponsoring some C$ 86 billion of ABCP announced they would offer unconditional "global style" liquidity protection.
- DBRS changed its ABCP rating criteria on September 13 to require global-style liquidity support.
- OSFI stress tests indicate that if banks put assets from sponsored conduits on their balance sheets, this would leave them with capital above regulatory targets, though those tests may not consider interruption of financing, asset price declines, or costs of holding "bridge loans."
- ABCP represented about half of the outstandings in the corporate short-term paper market: of C$ 223 billion short-term corporate paper outstanding on August 31, 2007, C$ 115 billion was ABCP, C$ 58 billion was bankers’ acceptances, and C$ 50 billion was direct corporate issuance. Of the C$ 115 billion ABCP, C$ 32 billion was issued by the "Montreal Proposal" conduits.

*Based on text in the source content provided.*

### 33.      The turmoil in global financial markets has thus far only had a modest effect on

### _cr0859 - 33.      The turmoil in global financial markets has thus far only had a modest effect on

### Impact on Canadian banks’ financial soundness
- Aggregate CAR of the five largest banks declined to 11.8 percent, from 12.4 percent in the fourth quarter of 2006.
- Earnings remained high and stable through the third quarter of 2007.
- At least one major bank expects substantial writedowns from exposures to U.S. subprime assets, amounting to perhaps one fifth of its capital and one quarter of its earnings over the last year, and has decided to raise additional capital through a common share issue.
- Other major banks face writedowns on a more modest scale.

### Market-based measures of banking stability
- Two-year probability of default (PoD) of a single Canadian bank implied by Moody’s KMV data increased to about 7 percent in mid-December, compared with 2 percent before the market turbulence began in August 2007, and remains well below the 14 percent seen in the United States.
- A banking stability index (BSI), defined in terms of the joint probability of default of the largest banks in the system, has increased commensurately.
- Note on BSI methodology: The BSI conceptualizes the banking system as a “portfolio of banks.” Using individual banks’ market measures of PoDs, the mission modeled the portfolio multivariate density (PMD), which is used to estimate the banking system’s joint probability of default. The PMD embeds both linear and nonlinear default dependence, allows for the change of default dependencies over time, and requires only a limited dataset.

### Other risks from cross-border and market activities
- Cross-border expansion focus: United States, Latin America, and the Caribbean.
- Strategy: More consistent and cautious than in the past; several banks exited international wholesale corporate banking and refocused on lower risk activities (primarily retail banking).
- Expansion of securities and capital market activities (investment banking, securities underwriting, brokerage, asset management) has been particularly profitable in recent years.
- Exposures and observed losses:
  - Small group exposure to pending leveraged buyout transactions and to hedge funds, but risks exist.
  - Example losses: one large bank in commodity trading in late 2006; writedowns related to CDOs and mortgage-backed securities (MBS) in other banks in the second half of 2007.

### Systemic liquidity and crisis management — framework and instruments
- Overall assessment: The financial safety net and crisis-management framework are well designed; interagency decision-making process is effective with the Financial Institutions Supervisory Committee (FISC) playing a key coordinating role.
- FISC composition: Governor of the Bank of Canada (BoC), the Deputy Minister of Finance, and the heads of OSFI, CDIC, and the Financial Consumer Agency of Canada. FISC usually meets quarterly, can convene more frequently.

#### A. Deposit insurance
- All retail depository institutions required to have insurance coverage.
- Main provider: Canadian Deposit Insurance Corporation (CDIC), a federal Crown corporation.
- CDIC membership open to most chartered depositories, with risk-based premiums and full coverage for deposits of up to C$ 100,000 per individual depositor per member institution.

#### B. Liquidity provision and BoC facilities
- Liquidity normally provided by the Bank of Canada through open market operations; monetary policy implemented around an announced target for the overnight interest rate with SPRAs conducted to inject liquidity as needed.
- Bank of Canada’s LoLR facilities:
  - Standing Liquidity Facility (SLF): routine overnight credit at the Bank Rate (set at 25 basis points over the overnight rate) to participants in the Large Value Transfer System.
  - Emergency Lending Assistance (ELA): more prolonged credit at or above the Bank Rate for a maximum term of six months, renewable at BoC discretion, to solvent depositories experiencing liquidity strains.
  - Facility to provide liquidity to any financial or nonfinancial firm (via outright purchases of a wide variety of claims) upon a finding of “severe and unusual stress on a financial market or financial system.”
- Collateral and eligibility:
  - LoLR liquidity is extended on a secured basis.
  - SLF eligible collateral list expanded in December 2007 to include certain types of ABCP sponsored by banks and U.S. Treasuries; further broadening expected in March 2008.
  - ELA acceptable collateral range broader, potentially including Canadian dollar nonmortgage loan portfolios.
  - SPRAs and sale and repurchase agreement operations normally limited to Government of Canada securities.
  - BoC uses private credit ratings to determine eligibility of, and haircuts on, privately issued collateral for its SLF.

#### Box 2 — The Bank of Canada’s response to the recent market turmoil (summary of authorities’ view and actions)
- BoC view: market instability beginning in August 2007 reflected a spike in credit-quality concerns triggered by events abroad.
- Primary focus: ensure overnight liquidity remained sufficient.
- Actions taken:
  - Increased supply of settlement balances via the SLF.
  - Broadened range of securities eligible for SPRAs.
  - Clarified procedures for potential activation of ELA and “severe and unusual stress” facilities as a precaution.
  - Confined liquidity support to pre-existing overnight instruments; chose not to depart from its established framework.
- Observed market conditions:
  - Overnight markets settled close to target; pressures persisted in the term money market (one-week to six-month maturities) with transactions at abnormally high rates.
  - Two term liquidity operations were announced in December 2007 to address year-end funding pressures, in coordination with other central banks.
- Policy considerations and concerns:
  - Officials skeptical about setting prices along a yield curve anchored by the overnight rate; recognized injections of term liquidity could be considered under certain conditions.
  - Debate over central bank role as “market-maker of last resort” and moral hazard concerns; potential interference with market repricing of credit risk.
  - Officials cognizant that the process of ascertaining losses and repricing credit risk could be protracted and that a global transparency premium in structured finance could limit future inclusion of CDOs in ABCP asset structures.

#### C. Failure resolution and crisis management powers and contingency planning
- Interagency coordination through FISC.
- OSFI enforcement powers include authority to intervene progressively under “structured early intervention” with a four-stage process culminating in closure even while capital may remain positive.
- CDIC responsibilities: bank resolution under least-cost resolution requirements (never waived to date); authority to make independent determinations on viability, terminate/cancel insurance coverage, or assume receivership.
- CDIC financial resources and authorities:
  - C$1.6 billion contingency fund.
  - Standing authority to borrow up to C$6 billion.
  - May apply for special appropriations from the government under an expedited process.
- Recommendation: Reduce room for discretion in bank intervention and resolution.
  - Observation: “Structured early intervention” provides for, but does not mandate, specific supervisory actions as certain capital thresholds are breached.
  - Observation: Minister may waive certain CDIC interventions for public interest reasons.
  - Conclusion: Current framework provides considerable scope for supervisory discretion and regulatory forbearance; reducing discretion would buttress transparency.

#### D. Payment and settlement systems
- Canadian Payments Association operates LVTS (Large Value Transfer System) and ACSS (Automated Clearing Settlement System).
  - LVTS: principal system for large-value and time-critical payments; one tranche based on netting with deferred settlement while netting balances tracked in real time; risk management framework backed by collateralization and BoC intraday liquidity ensures intraday finality; provides cash settlement leg of securities clearing system.
  - ACSS: primarily retail payment oriented with standard netting and deferred settlement.
  - Minister of Finance has statutory oversight responsibilities over the Canadian Payments Association and its systems.
- CDS and CDSX:
  - CDS is the national securities clearing and settlement organization, owned by The Canadian Depository for Securities Limited.
  - CDSX provides clearing and settlement for equities and debt; designated by BoC as systemically important.
  - CDSX settles high value debt securities transactions and supports collateral used in many financial arrangements, including central bank intraday liquidity for LVTS and the securities leg of monetary policy operations.
- Assessment and recommendations for CDSX:
  - Assessment vs. CPSS/IOSCO RSSS: the system is sound, efficient, and reliable, and complies with almost all RSSS.
  - Recommendations:
    - CDS should assess the benefits and costs of acting as a CCP for TFT transactions.
    - CDS could consider introducing a securities lending facility to reduce settlement failure.
    - Authorities should strongly consider separating CCP functions from CDS functions, with the CCP provided by a distinct legal entity, to protect CDSX from credit and liquidity risks inherited in CCP services.
    - CDS should take steps to further reduce concentration of settlement cash for U.S. dollar-denominated securities in a single settlement bank; consider becoming a direct member of Fedwire or obtaining access to U.S. dollar central bank money through the BoC.
    - Cooperative arrangements between the Bank of Canada and securities regulators (notably OSC and Autorité des Marchés Financiers) could be formalized, as could arrangements between Canadian and relevant United States authorities for cross-border activities.
    - CDS should not allow transfer of securities delivered through the depository trust company (DTC) link to its participants until those securities reach settlement finality in the DTC system.

### Financial regulation and supervision — framework and recent reforms
- OSFI is the primary regulator and supervisor for federal financial institutions, operating on principles of consolidated supervision, a risk-based approach, and early intervention.
- Institutional coverage as of September 15, 2007:
  - 150 deposit taking institutions,
  - 308 insurance companies,
  - 34 foreign bank representative offices.
- Canada’s five year review process for financial sector legislation (2006 review highlights):
  - Improving disclosure to consumers (strengthened disclosure regime for deposit-type investment products and associated fees).
  - Modernizing check payments (enabling framework for electronic check imaging; measures to shorten check holding period).
  - Foreign banks: lighter entry regulation for “foreign near banks” (entities providing bank-type services but not regulated as banks in home jurisdictions).
  - Mortgage insurance: threshold loan-to-value ratio for mandatory mortgage insurance raised from 75 percent to 80 percent.
  - Credit unions and caisses populaires: ability to incorporate cooperative credit associations to operate across provinces; associations may opt out of deposit insurance if they do not accept retail deposits.
  - Ownership regime thresholds: equity threshold for large banks (widely held) and medium sized banks (35 percent public float requirement) raised to C$ 8 billion and C$ 2 billion from C$ 5 and C$ 1 billion respectively.
- Post-crisis reforms have focused on reducing supervisory forbearance and aligning supervisory incentives with deposit insurers; CDIC equipped with extensive failure resolution powers.
- Minister of Finance responsibilities and discretion:
  - Incorporation of banks, permitting foreign bank branches, and review of large bank mergers.
  - Only federal government may incorporate banks; Minister has discretion to issue letters of patent of incorporation.
  - OSFI oversees public notification and inquiry into authorization process.
  - OSFI requires consent from home country supervisor for opening foreign bank subsidiaries or branches; factors include financial resources, appropriateness of business plan, and fitness of management.
  - Regulations on foreign bank branches (including restrictions on taking retail deposits) may limit potential cost savings from cross-border branching.
- Large bank mergers: undergo competition review and prudential review involving Competition Bureau, OSFI, and Ministry of Finance; Minister of Finance has broad legal discretion to disapprove a merger. Over the past decade debate on ministerial discretion and a “public interest test” in draft merger guidelines has been prevalent; current government has set aside this issue indicating bank mergers are not a priority at this time.

*Source: _cr0859 - 33.      The turmoil in global financial markets has thus far only had a modest effect on (PDF).*

### 54.      In contrast to banking regulation, securities laws and regulations are still under

### _cr0859 - 54.      In contrast to banking regulation, securities laws and regulations are still under

### Fragmentation of securities regulation (provincial control)
- Securities laws and regulations remain under provincial control, resulting in a fragmented domestic capital market.
- Only some proportion of Canadian public companies have nationwide access to investors.
- A more protracted registration process and fees in multiple jurisdictions may deter smaller entities.

### Pension plans governance and tax registration
- Pension plans are governed and monitored by federal or provincial pension legislation to protect members’ rights and set minimum standards.
- For businesses under federal jurisdiction (airports, airlines, banks, telecommunications), plans fall under federal pension legislation and OSFI supervision.
- Non-federal employers register pension plans in the province where the plurality of employees report to work.
- Both federally and provincially regulated pension plans must be registered with the Canada Revenue Agency to benefit from tax-deferred treatment under the Income Tax Act, ensuring adherence to rules and limits on contributions and benefits.

### Focused review of banking supervision (FSAP findings)
- The 1999 FSAP found Canada to be fully compliant with the BCPs (with two Additional Criteria later addressed).
- The 2006 revision of the Core Principles (CPs) led to a focused review of four CPs; OSFI was found compliant with all four:
  - CP 14 (Liquidity Risk)
  - CP 15 (Operational Risk)
  - CP 16 (Interest Rate Risk in the Banking Book)
  - CP 20 (Supervisory Techniques)
- OSFI’s supervision is risk-focused and “reliance-based,” leveraging banks’ work to minimize duplication and regulatory costs.
- The review notes the need for additional resources for cross-checking submissions provided by financial institutions, including on-site inspections.

### Basel II preparation (Box 4)
- Basel II came into effect in Canada at the beginning of November 2007, with an approval process starting in August 2007 and ending in February 2008.
- Transition is single-phase; large banks opting for internal ratings use only the advanced internal ratings-based approach (AIRB). The foundation internal ratings-based approach is not an option.
- Other banks adopt the standardized approach (SA).
- OSFI actions:
  - Issued an implementation note on approval of internal rating-based approaches and other implementation notes (e.g., operational risk).
  - Issued self-assessment instructions and schedules.
  - Designed an AIRB risk rating system scorecard to rate banks’ self-assessments.
- Resources devoted to Basel II preparation: 20 persons (including some with quantitative and information technology skills).
- About 140 banks are adopting SA.

### Implementation of IOSCO Principles for securities supervision
- Regulatory framework shows a high degree of implementation of the IOSCO Principles.
- In the largest provinces, regulatory authorities are independent, self funded, have sufficient resources and skilled personnel, and are clearly accountable to the government.
- Framework for issuers, SROs, market intermediaries, and secondary markets is robust.
- Improvements could be made in on-site inspections of SROs.
- Coordination between 13 regulatory agencies has significantly improved under the CSA.
- Enforcement:
  - Positive changes in recent years, but further improvement needed.
  - Criminal and securities law matters are enforced by different authorities that can cooperate.
  - Criminal enforcement appears particularly weak; fragmented provincial regulation creates challenges for securities law enforcement.
  - A coordinated approach with clear lines of accountability and benchmarks between criminal and securities law enforcement is needed.
  - Retention of qualified personnel is a challenge, especially for criminal enforcement.

### Collective investment schemes (CIS) supervision gaps
- Under the current framework, CIS operators are not subject to a registration regime, limiting the ability of regulatory agencies to impose eligibility criteria and full disciplinary authority.
- CIS operators may be deemed “market participants,” giving regulatory agencies some limited powers.
- Weaknesses expected to be corrected with approval of National Instrument 31–103 Registration Requirements (currently under consultation in the source).
- Supervision of mutual funds and their operators is not a regular part of the oversight program of at least one major regulatory agency, although targeted reviews have been carried out.

### Structure of securities regulation and reform proposals
- Securities markets operate under provincial regulation and supervision, resulting in 13 regulatory authorities each administering separate securities laws and regulations.
- Under the CSA, provincial regulators aim to coordinate actions.
- Coordination achievements:
  - Mutual reliance review system for issuers and CIS under a highly harmonized regulatory framework (others retain authority to opt out).
  - National Registration System developed for registrants (regulatory harmonization not yet complete).
  - More progress in coordinated oversight for exchanges than for SROs; a committee on enforcement has been constituted.
- Areas needing improvement:
  - Further harmonization of regulations.
  - Simplification of registration processes and oversight arrangements.
  - Reduction of costs and improvement of policy development and enforcement processes.
- Two reform proposals:
  - The passport system: home-jurisdiction regulator decisions would automatically apply in other jurisdictions.
  - A common regulator: a single securities commission accountable to the Council of Ministers (provinces, territories, federal government).

### Passport system details and limitations
- Passport system being implemented (agreed by all provincial governments except Ontario).
- Under passport:
  - Participants deal only with regulator of their home province; decisions automatically apply to all provinces and territories, with no opt-out.
  - Interface with the OSC will extend passport benefits to participants located in Ontario; OSC retains authority to opt out of decisions by other regulators.
  - Further harmonization of regulations for issuers, CIS, and intermediaries will come into effect with the passport system.
- Limitations of the passport system:
  - Does not address fees paid to regulatory authorities of all provinces where participants raise capital or provide services—affecting cost and access to funding.
  - Council of Ministers has instructed the CSA to review the fee system.
  - Policy development still requires approval by 13 jurisdictions, which may delay timely reactions to local and global developments.
  - Does not resolve limited jurisdiction of regulatory agencies or fragmented enforcement challenges; effective enforcement requires coordination with other enforcement agencies.
  - Delegation of powers will face challenges regarding consistent application across provinces and will require creation of an oversight system.

### Single regulator assessment (staff’s view)
- A single regulator (including alternatives such as the “common regulator” proposed by the Crawford Panel) appears better positioned to address shortcomings.
- Potential benefits of a single regulator:
  - Reduced compliance costs via a single system of fees.
  - Streamlined policy development and faster response to local and global developments.
  - Nationwide enforcement authority to eliminate inefficiencies of limited provincial enforcement authority.
  - Simplified coordination with other enforcement agencies through a single administrative enforcement authority.
- Appendix II provides background on this assessment in the source.

### Retirement savings, pension funds, and risks
- Pension funds are diversifying away from traditional and domestic asset classes due to:
  - Decline in size of government (and provincial) bond markets.
  - Increased buyout transactions and M&A activity.
- Noteworthy developments: rapid growth of the Maple bond market and the Canadian Mortgage Bond program; further development of mortgage securitization would be helpful.
- Larger pension funds move toward global and more complex investment policies in broader asset classes, including hedge funds, private equity, and infrastructure.
- Risk management needs:
  - Continued reinforcement of risk management skills in pension funds and supervisors.
  - Poor risk management and large losses could lead to political pressure for bailouts.
  - Substantial challenges exist in investing in foreign markets and in complex, hard to value, and often illiquid instruments (example cited: Caisse des Dépots acquired large exposures to third-party ABCP conduits).
- Large number of medium and small defined benefit pension funds may find operating costly; innovative solutions could be considered:
  - Encouraging larger, multi-employer pension plans.
  - Facilitating access of pension plans to the (re)insurance market for instruments to manage extreme risks.
  - Possible affiliation with, or outsourcing to, sophisticated money managers or large pension plans—implementation would require negotiation on contribution rates, benefit accruals, etc.
- Regulatory framework for pension funds should increasingly focus on adequacy of risk management practices and resources in addition to traditional solvency approach.
- Risk-based prudential approach being developed further; reflections ongoing in a number of provinces.

### Appendix I — Focused review summaries of CPs
- CP 14 (Liquidity risk):
  - Regular review part of OSFI’s risk-based planning.
  - For large banks, quarterly monitoring with off-site monitoring and discussions with management; stress-testing, modeling, worst case scenarios, and internal controls reviews regularly performed.
  - For smaller institutions, lighter process relying on verified reports; OSFI checks contingency plans and internal monitoring.
  - OSFI intensifies supervisory activities as warranted and is exercising supervisory functions in ABCP and money market turmoil.
- CP 15 (Operational risk):
  - Operational risk analysis integral to OSFI’s supervisory framework; banks required to comply with Basel Committee’s Sound Practices and OSFI guidance.
  - OSFI has a specialized operational risk unit and methodologies (e.g., information technology risk scoring algorithm).
  - Heavy reliance on banks’ own reporting could be more systematically addressed in on-site examinations.
  - Staffing in operational risk area seems relatively low compared to other advanced economies but commensurate given expected low adoption of AMA.
- CP 16 (Interest rate risk in the banking book):
  - OSFI issued a Guideline on Interest Risk Management referencing Basel Committee’s July 2004 document.
  - Larger banks monitored quarterly via off-site reporting, benchmarking, review of internal audit reports; OSFI verifies board and senior management involvement.
  - For smaller institutions, OSFI relies more on banks’ reports; institutions warranting attention receive more detailed examination.
  - OSFI plans to make interest rate risk assessments more forward-looking and quantitative.
- CP 20 (Supervisory Techniques):
  - OSFI has a well-balanced organization, robust processes, well elaborated documentation, suitable methodologies, up-to-date tools, adequate and competent staffing, and sufficient legal powers.
  - On-site, off-site, and oversight work are efficiently blended with good internal communication.
  - OSFI is risk-focused and “reliance-based,” but additional resources are warranted for cross-checking submissions provided by financial institutions, including on-site inspections.

### Appendix II — Background on regulatory structures internationally
- International experience shows a variety of institutional structures: trends toward fewer separate agencies and more integrated arrangements, but no single convergent model.
- Examples of structures among advanced countries:
  - Fully unified regulator (England).
  - Twin peak approach: prudential regulation to one regulator and market conduct regulation to another (Australia; partially Italy and Portugal).
  - Specialized regulators (United States).
- Division of labor between central governments and states/provinces varies; some advanced countries retain state regulators’ roles in securities regulation (Germany, United States).
- Effectiveness and efficiency—meeting objectives without imposing unnecessary costs—are the ultimate criteria for choosing regulatory structure.

*Source: _cr0859 - 54.*

### 75.      The structure of securities regulation in Canada has been the subject of

### _cr0859 - 75.      The structure of securities regulation in Canada has been the subject of

### Overview of recent reviews and research
- Recent task forces: Five Year Review Committee; Wise Persons Committee; Crawford Panel; Allen Task Force.
- Considerable academic research exists, much in response to task force work.
- The FSAP team received a background paper: Briefing Note: Canada’s Securities Regulatory Regime, August 16, 2007.
- Of 77 submissions that make specific recommendations on the best regulatory structure for Canada, 74 percent recommended a single regulator and 13 percent recommended a passport system.

### General assessment and enforcement
- Broad agreement that the current structure has provided Canada with an effective system of regulation, although enforcement is in need of further improvement.
- IOSCO Principles assessment concluded enforcement needed strengthening.
- Multiple provincial regulators allow accommodation of capital market characteristics (large presence of small issuers; concentration of certain industries in specific provinces) but impose higher compliance costs on market participants operating in more than one province.

### Scope to rationalize the system — main issues
- Need to harmonize laws and regulations.
- Need to expedite policy development.
- Need to simplify registration processes and oversight arrangements for market participants (issuers, registrants, exchanges and SROs).
- Need to reduce costs and strengthen enforcement.
- Under the umbrella of the CSA, provinces have taken initiatives; significant progress has been made, but important concerns remain.

### Specific findings (areas requiring attention)
- Harmonization of regulations:
  - Significant progress via adoption of national instruments.
  - Particular efforts needed on securities intermediaries.
- Policy development:
  - Adoption of national instruments is protracted because they must be individually adopted by each province; depending on jurisdiction, ministerial approval may also be needed.
  - Provinces retain full authority to adopt a local standard despite commitments to harmonization.
  - The Crawford Report noted that the implementation of a CSA multilateral instrument takes a minimum of 18 months.
- Issuers and intermediaries registration:
  - Mutual Reliance Review System for issuers and the National Registration System for intermediaries have streamlined registration.
  - Opt-outs prolong and create uncertainty in the process.
- Costs:
  - Multiple regulators entail additional costs: direct fees to each provincial/territorial regulator; compliance costs; opportunity costs from longer review procedures.
  - Research cited (e.g., Charles River Associates; Canadian Bankers Association; Anita Anand and Peter Klein; Jean Marc Suret and Cécile Carpentier) provides evidence of significant incremental costs for intermediaries and issuers, though views vary.
- Authorization and oversight of exchanges and SROs:
  - Improvements via adoption of a “lead regulator” for exchanges and a “principal regulator” for SROs.
  - The principal regulator for SROs acts mainly as coordinator; approval of regulations developed by exchanges and SROs remains protracted since all provinces have a role.
- Enforcement:
  - CSA created a committee on enforcement improving coordination.
  - Provinces are increasingly conducting joint investigations and, to some extent, joint hearings; a few provinces have powers to reciprocate orders.
  - These steps alleviate but do not eliminate jurisdictional limits of provincial regulators and complicate coordination with criminal enforcement authorities.
  - The Royal Canadian Mounted Police has created integrated market enforcement teams.

### Passport system
- Represents an improvement over the current system:
  - Further rationalizes registration process for issuers and intermediaries.
  - A participant will deal only with the regulator of its home province; decisions of that regulator automatically apply to the rest of provinces and territories with no opt-out provision.
  - Further harmonization of regulations for issuers and securities intermediaries will come into effect along with the passport system.
- Limitations:
  - Does not address many remaining inefficiencies (e.g., policy development delays, fee system separation).
  - Delegation of powers under the passport system will require a system of oversight.

### Market participants’ views
- Many market participants see advantages in a single regulator.
- The 12 provinces that have joined the passport system acknowledge challenges in policy development and a separate system of fees but prefer solutions that do not involve creating a single or national regulator.
- The AMF has acknowledged delays in policy development and noted the Council of Ministers has asked the CSA to analyze and make recommendations on the fee system.

### IOSCO assessment — methodology and scope
- An assessment of the Canadian Securities Market was conducted September 10–21, 2007 as part of the FSAP by Ana Carvajal, Monetary and Capital Markets Department.
- Assessment based on the IOSCO Principles and Objectives of Securities Regulation and the associated Methodology adopted in 2003.
- A CPSS/IOSCO Assessment was conducted separately; thus Principle 30 was not assessed in this IOSCO assessment.
- Given impossibility of assessing all provinces, the assessment largely relied on the regulatory frameworks of Ontario and Quebec to infer country-level implementation, justified by high level of harmonization via National Instruments and the significance of these two provinces to market activity.
- Sources used: self-assessments by the OSC and the AMF; review of laws, regulations, procedures, manuals, guidelines; meetings with OSC and AMF boards and staff; meetings with Finance Canada and the Bank of Canada; meetings with market participants (issuers, intermediaries, market operators, SROs).

### Regulatory structure and practices (description)
- Securities markets in Canada are under provincial regulation and supervision, resulting in 13 regulatory authorities each administering separate securities laws and regulations.
- Underlying objectives across provinces: protection of investors and ensuring fair, efficient capital markets; regulators share the same core responsibilities, though specific regulations and obligations differ across provinces.
- Nature, structure, resources, and powers of provincial regulators vary:
  - In smallest provinces regulators remain part of government, funded by it, with limited resources.
  - Four largest jurisdictions—Alberta, British Columbia, Ontario and Quebec—roughly supervise 95 percent of the market; these agencies are operationally independent and fully self-funded by levies on market participants; they have comprehensive powers including enforcement.
  - In the case of the AMF, enforcement powers are exercised through an independent tribunal, the Bureau de Décision et de Révision en Valeurs Mobilières.
- CSA (Canadian Securities Administrators) is a nonstatutory association of all Canadian securities regulatory authorities aiming to improve regulation and harmonization via national instruments and their administration.
- Authorization and supervision progress:
  - Mutual reliance review system for issuers and CIS: decisions taken by one regulator under a harmonized framework, with others retaining opt-out authority.
  - National Registration System developed for registrants, though full regulatory harmonization has not yet occurred.
  - Coordinated approach for exchanges and SRO oversight with more progress at exchange level.
- Provincial regulators rely largely on SROs for regulation and supervision:
  - Main SROs: Investment Dealers Association of Canada (IDA); Mutual Fund Dealers Association of Canada (MFDA); Chambre de la sécurité financière (CSF) in Quebec; Market Regulation Services Inc. (RS); Montréal Exchange recognized as SRO.
  - Equity exchanges (TSX and TSXV) considered SROs but have outsourced market regulation to RS.
  - IDA and RS have submitted a proposal for merger to regulators.

### Market structure
- Specialized securities intermediaries with categories and requirements that vary across provinces:
  - General categories: investment dealers, mutual fund dealers, advisors.
  - Investment dealers and mutual fund dealers generally required to be members of an SRO (IDA or MFDA), except in Quebec where mutual fund representatives are members of the CSF while mutual fund firms are not.
  - Membership in SROs has de facto harmonized requirements for investment dealers and mutual fund dealers (except mutual fund dealers in Quebec).
- Exchanges operate under specialization:
  - TSX and TSXV specialize in equity (senior and junior, respectively); MX is a derivatives market under a noncompetition agreement.
  - In December 2007, TSX and MX agreed to combine organizations to create TMX Group Inc.; new organization to be managed from Toronto while trading of financial derivatives products will stay in Montreal.
  - The merger deal is subject to approvals from regulators and MX shareholders and was expected to close in the first quarter of 2008.

*Source: Excerpt from FSAP chapter on securities regulation in Canada (paragraphs 75–91 and related annex material).*

### 92.      The TSX is the 7

### _cr0859 - 92.      The TSX is the 7

### Market structure and international linkages
- As of December 2006, market capitalization of the TSX Group amounted to US$1,701 billion.
- The TSX is the 7th largest equity market by market capitalization.
- It ranks 12th by value of equity trading, with a traded valued of US$1,282 billion for 2006.
- In 2006 there were 195 interlisted issuers out of 1,598 TSX-listed issuers, for a combined market value of US$1.2 trillion or 61 percent of total domestic market.
- Regulators have developed a Multijurisdictional Disclosure System, under which issuers from the United States and Canada largely rely on the filings that they produce in their home countries for purposes of the cross listing.
- Equity marketplaces referenced: Toronto Stock Exchange (TSX), TSX Venture Exchange (TSXV), Canadian Trading and Quotation System, and several alternative trading systems (ATS).

### Regional concentration and market participants
- Approximately 31 percent of listed issuers are based in Ontario.
- These Ontario-based issuers amount to 46 percent of Canada’s equity markets.
- 60 percent of IDA members firms have their Canadian head office in Ontario.
- 76 percent of CIS assets are held by firms based in Ontario.
- 49 percent of the assets of the top 100 employer funds are held by Ontario based pension funds.

### General preconditions for effective securities regulation
- Preconditions identified as present in Canada: sound macroeconomic policies, appropriate legal, tax and accounting frameworks, and the absence of entry barriers to the market.

### Main findings — Regulator principles
- The largest regulatory agencies work independently of the government under a vigorous system of accountability.
- They are funded by levies imposed on market participants; self funding has allowed them to retain sufficient qualified personnel.
- Regulatory agencies are subject to a high degree of transparency, including public consultation on regulations and published policy statements.
- An ethics code with certain reporting obligations codifies high standards of ethics.
- Regulators are active on investor education.
- Under the umbrella of the CSA, provincial regulators are coordinating actions with uneven progress; most progress achieved for issuers, CIS, and registrants.

### Main findings — SROs
- SROs are subject to authorization based on eligibility criteria addressing financial viability, capacity to carry out functions, governance, and fair access.
- Supervision mechanisms include off-site reporting, on-site inspections, regular meetings, and close contact with SRO staff.

### Main findings — Enforcement
- Canada has a credible system for supervision of the market and its participants in which SROs play a significant role.
- Enforcement has improved recently but still needs considerable improvement.
- Matters of a criminal nature and securities law matters are enforced by different authorities; these authorities can and do cooperate in certain circumstances.
- A coordinated approach to enforcement between criminal and securities law enforcement, with clear lines of accountability and benchmarks, appears to be missing.
- Both federal authorities and provincial regulators have taken important steps toward coordination.

### Main findings — Cooperation
- The largest regulatory agencies have explicit and comprehensive powers to share information with both local and domestic authorities without need of external approval.
- The four largest jurisdictions are signatories of the IOSCO Multilateral Memorandum of Understanding (MMoU).
- They have the power to obtain information that is not in their files on behalf of foreign regulators and have shown commitment to exchange information and assist other regulatory agencies domestically and internationally.

### Main findings — Issuers
- Issuers are subject to disclosure obligations at authorization and on an ongoing basis, fully in line with IOSCO standards.
- Regulatory agencies have developed a system for review of the prospectus as well as continuous disclosure obligations.
- Liability provisions are in place to ensure issuers’ responsibility for the prospectus.

### Main findings — Collective Investment Schemes (CIS)
- CIS operators are not subject to a registration regime; consequently regulatory agencies cannot impose eligibility criteria on them, and it is questionable whether they can exercise full disciplinary powers.
- Some risks from this gap are mitigated because under securities laws CIS operators are considered “market participants” and are subject to certain minimum obligations.
- Public offerings of CIS are subject to disclosure requirements at authorization and on an ongoing basis, fully in line with IOSCO principles.
- There are rules on separation of assets; however not all CIS are required to have a custodian.
- Supervision of mutual funds and their operators is not a regular part of the oversight program of at least one major regulatory agency, although the agency carries out targeted reviews.

### Main findings — Market intermediaries
- Market intermediaries (investment dealers, mutual fund dealers and advisors) are subject to a registration regime based on eligibility criteria including integrity, financial viability, and capacity to carry out services (including proper internal controls and risk management mechanisms).
- Supervision of investment dealers and mutual fund dealers (except in Quebec where mutual fund dealers are supervised by the AMF) is carried out by their respective SROs, which have developed risk assessment models to determine focus and frequency of inspections.
- Supervision of advisors (and mutual fund dealers in Quebec) is carried out by the regulatory agencies, also based on risk assessment models.
- Investment dealers and mutual fund dealers are required to participate in contingency funds.

*Source: _cr0859 - 92.      The TSX is the 7 (PDF chapter/section).*

### 102.     Principles for secondary markets—The operation of an exchange is subject to an

### Principles for secondary markets—The operation of an exchange is subject to an authorization regime based on eligibility criteria that include financial viability, capacity, governance, and fair access.

### Market structure, surveillance, transparency, and clearing
- Exchanges: Subject to an authorization regime based on eligibility criteria that include financial viability, capacity, governance, and fair access.
- Alternative trading systems (ATS): Regulated as dealers subject to certain market requirements; framework allows regulatory agencies to regulate them as exchanges once they reach a certain threshold.
- Surveillance: Exchanges have developed mechanisms for market surveillance, complemented by regulatory surveillance. There are plans to deal with market disruptions, although in one of the agencies these should be further developed.
- Transparency: There is sufficient pre-trade transparency to market participants and post-trade transparency to both market participants and the public.
- Clearing: The two main clearing entities, one for securities and the other for derivatives, have developed reasonable mechanisms to manage large exposures including selection criteria for clearing members, margins and collateral.

### Table 4 — Summary Implementation of the IOSCO Principles: Key findings by principle
- Principle 1. The responsibilities of the regulator should be clearly and objectively stated
  - Responsibilities of the regulatory agencies are clearly stated in the law. Under the umbrella of the CSA, provincial regulators are coordinating their actions, although certain areas still require further improvement.
- Principle 2. The regulator should be operationally independent and accountable in the exercise of its functions and powers
  - The largest regulatory agencies are independent and fully self-funded by levies imposed on market participants. There is a strong system of accountability to the government and to the public that includes ministerial approval of the budget, annual audit of financial statements, an annual report of activities, and judicial review.
- Principle 3. The regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers
  - The regulatory agencies have sufficient powers to regulate the market and its participants; except for registration of CIS operators. The largest agencies have also been able to hire and retain personnel with the necessary expertise.
- Principle 4. The regulator should adopt clear and consistent regulatory processes
  - The regulatory agencies are subject to a high degree of transparency including public consultation of regulations and policy statements. They are active on investor education.
- Principle 5. The staff of the regulator should observe the highest professional standards
  - The regulatory agencies have developed codes of ethics. Reporting obligations on investment activities are in place as well as mechanisms to monitor compliance.
- Principle 6. The regulatory regime should make appropriate use of SROs that exercise some direct oversight responsibility for their respective areas of competence and to the extent appropriate to the size and complexity of the markets
  - SROs play a significant role in the supervision of the market and its participants. SROs include the IDA, the MFDA, the RS, the MX, and the CSF.
- Principle 7. SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities
  - SROs are subject to an authorization regime based on eligibility criteria that address issues of integrity, financial viability, capacity, governance and fair access. SROs are subject to oversight through periodic reporting; on-site inspections under a periodic cycle (approximately three years) and regular meetings.
- Principle 8. The regulator should have comprehensive inspection, investigation and surveillance powers
  - The regulatory agencies have broad investigative and surveillance powers over regulated entities. In particular, they can conduct on-site inspections, including of books and records without prior notice; obtain books and records and request data or information without the need for a judicial action; and supervise exchanges and regulated trading systems.
- Principle 9. The regulator should have comprehensive enforcement powers
  - The regulatory agencies have broad enforcement powers. These include the power to seek injunctions; bring an application for civil proceedings; order the suspension of trading and the freezing of assets; compel information, documents, records and testimony from third parties (nonregulated entities) in the course of their investigations; impose administrative sanctions; seek quasi criminal actions; and refer matters to the criminal authorities.
- Principle 10. The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance program.
  - The regulatory agencies have implemented a credible system of supervision of the market and market participants. While enforcement has experienced positive change, further improvement is needed. The development of a coordinated approach to enforcement between criminal and securities law enforcement, with clear lines of accountability and benchmarks, seems to be missing.
- Principle 11. The regulator should have the authority to share both public and nonpublic information with domestic and foreign counterparts
  - The regulatory agencies have broad authority to share information with both domestic and foreign regulators and have done so even in cases where no memorandum of understanding (MoU) was in place.
- Principle 12. Regulators should establish information sharing mechanisms that set out when and how they will share both public and nonpublic information with their domestic and foreign counterparts
  - The four largest regulatory agencies are signatories of the IOSCO MMoU. They also have bilateral MoUs, including a MoU with the U.S. Securities Exchange Commission and the U.S. Commodity Futures Trading Commission.
- Principle 13. The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquiries in the discharge of their functions and exercise of their powers
  - The regulatory agencies have authority to assist foreign regulators in obtaining information that is not in their files.
- Principle 14. There should be full, timely and accurate disclosure of financial results and other information that is material to investors' decisions
  - Issuers are subject to disclosure requirements at the moment of authorization and on an ongoing basis.
- Principle 15. Holders of securities in a company should be treated in a fair and equitable manner
  - The framework for corporations addresses issues of shareholders rights, including notice of meetings; and special majorities for the approval of major changes. A mandatory tender offer is required for the acquisition of control of a listed company.
- Principle 16. Accounting and auditing standards should be of a high and internationally acceptable quality
  - Issuers are required to submit financial information in accordance to Canadian Generally Accepted Accounting Principles. Audits have to be conducted in accordance with Canadian Accounting Standards (Canadian AS).
- Principle 17. The regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme
  - CIS operators are not subject to registration. On site inspection is not part of the regular program for the oversight of CIS and its operators in at least one of the largest agencies; however targeted reviews have been conducted.
- Principle 18. The regulatory system should provide for rules governing the legal form and structure of collective investment schemes and the segregation and protection of client assets
  - The legal form and structure of CIS have to be disclosed in the prospectus, along with investor’s rights. There are provisions on separation of assets; however not all CIS are required to have a custodian.
- Principle 19. Regulation should require disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a collective investment scheme for a particular investor and the value of the investor’s interest in the scheme
  - CIS are subject to disclosure obligations at the moment of authorization and on an ongoing basis. The regulatory agencies have developed a system to review prospectus. A continuous obligations review system has been implemented recently.
- Principle 20. Regulation should ensure that there is a proper and disclosed basis for assets valuation and the pricing and the redemption of units in a collective investment scheme
  - CIS are required to value their portfolios at fair value. There are rules for disclosure of prices, subscription and redemption, and best practice regarding pricing errors.
- Principle 21. Regulation should provide for minimum entry standards for market intermediaries
  - Dealers and advisors are subject to a registration regime based on eligibility criteria that address integrity, financial viability, capacity, internal controls, and risk management. Supervision of intermediaries involves periodic reporting and on-site inspections.
- Principle 22. There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake
  - Market intermediaries are subject to minimum capital requirements as well as capital adequacy requirements. IDA and MFDA have an early warning system to detect problems in financial condition.
- Principle 23. Market intermediaries should be required to comply with standards for internal organization and operational conduct that aim to protect the interests of clients, ensure proper management of risk, and under which management of the intermediary accepts primary responsibility for these matters
  - IDA and MFDA rules contain detailed obligations on internal control and risk management as well as on business conduct.
- Principle 24. There should be a procedure for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk
  - The regulatory agencies have at their disposal a set of mechanisms to prevent and deal with a failure, including terms and conditions in the registration; an early warning system, powers to order cease of trading and plans to deal with market disruption—although in one case the plan should be further developed. Investment dealers and mutual fund dealers are required to contribute to compensation funds.
- Principle 25. The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight
  - Exchanges are subject to an authorization regime based on eligibility criteria that include integrity, financial viability, and capacity. ATS are regulated as dealers; however the framework allows the regulatory agencies to regulate them as an exchange once they reach certain threshold.
- Principle 26. There should be ongoing regulatory supervision of exchanges and trading systems, which should aim to ensure that the integrity of trading is maintained through fair and equitable rules that strike an appropriate balance between the demands of different market participants
  - RS has developed automated surveillance systems that allow them to detect unusual transactions. The MX automated surveillance system is still under development and presently consists more of post trade exception reports. These systems are complemented by surveillance by the regulatory agencies, in particular to detect insider trading. There is currently no MoU between RS and MX.
- Principle 27. Regulation should promote transparency of trading
  - Post trade information is available to the public for all markets, while some pre-trade transparency exists also, especially in the equity markets (e.g., TSX, TSXV) and exchange traded derivatives (MX).
- Principle 28. Regulation should be designed to detect and deter manipulation and other unfair trading practices
  - The Universal Market Integrity Rules contain provisions that prohibit market manipulation and other unfair practices. Similarly, the MX also has trading rules that cover manipulative or deceptive methods of trading. Practices that RS or MX could not pursue—such as insider trading—are in the framework of the regulatory agencies. Some also constitute criminal offenses (for example, insider trading).
- Principle 29. Regulation should aim to ensure the proper management of large exposures, default risk and market disruption
  - The Canadian Depository for Securities Limited (CDS) and the Canadian Derivatives Clearing Corporation have developed mechanisms to manage large exposures, including capital requirements for clearing members, margins, collateral and caps on the transactions that can be entered for settlement.
- Principle 30. Systems for clearing and settlement of securities transactions should be subject to regulatory oversight, and designed to ensure that they are fair, effective and efficient and that they reduce systemic risk
  - A separate CPSS-IOSCO assessment was conducted.

### Table 5 — Recommended Action Plan (selected recommendations)
- Principle 1
  - The provincial regulators should continue to improve coordination.
- Principle 3
  - The provincial regulators should impose a registration system for mutual fund operators. Approval of proposed National Instrument Registration Requirements 31–103 and related statutory amendments would achieve this goal.
- Principle 7
  - 1) The provincial authorities should further streamline coordination of regulation and supervision of SROs, including the approval process for regulations.
  - 2) The AMF should conduct an on-site inspection of CSF.
  - 3) The provincial regulators should explore a shorter cycle of on-site inspections for SROs, in particular the IDA and the MFDA.
  - 4) The provincial regulators should explore requesting from RS an annual self assessment of the performance of its regulatory function.
- Principle 10
  - 1) The provincial regulators should give priority to the discussion of the report from the task force appointed by the federal government.
  - 2) The provincial regulators along with the federal government should work towards the adoption of a coordinated strategy for enforcement, with clear lines of accountability and benchmarks. A formal MoU is encouraged.
  - 3) The OSC and the AMF should continue to commit to reduce the time necessary to conduct an investigation and have the case ready for litigation.
  - 4) The CSA could explore compilation of additional statistics for enforcement activity, including timeliness of procedures.
- Principle 12
  - 1) The AMF and the Government of Quebec should work together on defining an efficient procedure for the approval of MoUs.
- Principle 14
  - 1) The assessor encourages the Government of Quebec to give prompt approval to the new framework for derivatives markets.
  - 2) The assessor encourages all provincial regulators to expand liability to continuous disclosure obligations.
- Principle 17
  - 1) The provincial regulators should establish a registration regime for CIS operators. Approval of proposed National Instrument Registration Requirements 31–103 would achieve this goal.
  - 2) The AMF should include on-site inspection as a regular part of its supervision of CIS.
  - 3) The provincial regulators should continue to enhance the continuous disclosure review system for CIS, if necessary with the development of a more defined risk based approach.
- Principle 18
  - The provincial regulators should require all CIS to have a custodian. Approval of proposed National Instrument 41–101 would achieve this goal.
- Principle 21
  - 1) The provincial regulators should harmonize regulations for market intermediaries. Approval of proposed NI 31–103 on Registration Requirements would achieve this goal.
  - 2) The Government of Quebec should explore bringing mutual fund dealers under the Securities Act.
- Principle 26
  - The MoU between RS and MX should be finalized.
- Principle 27
  - The provincial regulators should explore whether additional transparency is needed in the government debt market.

### Authorities’ response
- The authorities are largely in agreement with the results of the IOSCO assessment.
- They emphasized that the adoption of proposed National Instrument NI 31-103-Registration Requirements will address the gaps in the regulatory framework for collective investment scheme operators.
- The approval of proposed National Instrument 41-101 will extend custodian requirements to all types of collective investment schemes.

### Securities settlement system assessment — scope and institutional overview
- Assessment context: The assessment of the securities settlement system in Canada was undertaken in the context of the IMF FSAP update for Canada in September 2007 by Elias Kazarian, Monetary and Capital Markets Department.
- Information and methodology: The Canadian authorities were fully cooperative and all relevant documentation needed for the assessment of the securities settlement system was provided on time and without difficulty. The CDS conducted a self-assessment. The assessment covers CDSX as the settlement system for a broad range of securities, such as equities, government bonds and corporate bonds traded both on regulated markets and OTC. The assessment does not cover the CCP function of CDSX. This function should be assessed against the CPSS/IOSCO Recommendations for Central Counterparties, which cover broader aspects of CCP activities. However, some related aspects of the CCP function are discussed in order to assess the settlement system.
- Institutional structure
  - CDS Clearing and Depository Services Inc. (CDS) is the national securities clearing and settlement organization. It operates the CDSX system, which provides clearing and settlement functions for equities and debt securities.
  - CDS is a wholly-owned subsidiary of The Canadian Depository for Securities Limited (CDS Ltd.), a private business corporation, incorporated under federal law, owned jointly by major banks, the Investment Dealers Association, and the Toronto Stock Exchange (TSX).
  - CDS Ltd. is also a holding company for CDS Inc., a separate subsidiary of CDS that provides regulatory information services, and CDS Innovations Inc., a commercial service provider of securities-related information and publications.
  - CDS Ltd. provides a range of administrative, information technology, and risk management services to the CDS and the other two subsidiaries, CDS Inc. and CDS Innovations Inc.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr0859.pdf*

### 106.     The CDSX is the only securities settlement system in Canada and clears and

### The CDSX is the only securities settlement system in Canada and clears and

### Overview
- Introduced in 2003, replacing separate platforms for clearing and settling different types of securities.
- As of end-2006, the CDS had 100 participants, including domestic private financial institutions, foreign financial institutions and securities depositories, the BoC, some government enterprises, and the Canadian Derivatives Clearing Corporation.
- In 2006:
  - securities held in custody averaged C$ 3 trillion;
  - the average daily value of all transactions settled in the CDSX totaled C$ 230 billion;
  - the average number of daily transactions was 405,800.
- Provides cross-border settlement services, notably the New York Link and DTC Direct Link with the Depository Trust and Clearing Corporation (DTC) in the United States.
- CDS acts as a sponsor for participants subscribing to U.S. cross-border services, but does not act as a CCP in those services.
- CDS uses commercial banks to settle the cash leg of U.S. dollar-denominated cross-border transactions.
- The Bank of Canada (BoC) has federal oversight responsibility for CDSX; provincial regulatory responsibility for CDS as a clearing house rests with the OSC and the AMF. Coordination among authorities is on an ad-hoc basis.

### Legal framework (Rec. 1)
- Clearing and settlement activities are governed by a consistent set of laws, regulations, and contractual arrangements forming a sound legal foundation.
- The regulatory framework is clear and transparent to service providers and market participants.
- Key regulation: federal Payment Clearing and Settlement Act, enacted in 1996 and amended in 2007, which:
  - provides legal protection to settlement rules and procedures and netting arrangements;
  - empowers the BoC to designate systems with the potential to create systemic risk and to oversee them.
- The Ontario Securities Act and the Quebec Securities Act recognize, authorize, and regulate the clearing house to conduct clearing and settlement activities.
- There is no zero-hour rule in Canada.

### Presettlement risk (Rec. 2–5)
- Trade confirmation and settlement cycles:
  - All trades between direct market participants are confirmed the same day.
  - Settled on a rolling settlement cycle: three days after trade execution for equities; between zero and three days for debt instruments (depending on instrument type and maturity).
  - OTC transaction settlement may occur later per participant agreement; market convention is to follow procedures for traded instruments.
- Evaluation of settlement cycle shortening concluded any further shortening should take place at a later stage.
- CCP role:
  - CDS acts as CCP for cash payments arising from all securities transactions settled in CDSX.
  - CDS acts as CCP on the securities leg of transactions settled in the net settlement services.
  - No current discussions to expand net settlement services to include all securities in CDSX.
  - Issues related to CCP regulation, risk management, financial strength, and efficiency are covered by the CPSS/IOSCO Recommendations for CCPs.
  - CDS has undertaken a self-assessment against these Recommendations; Canadian authorities are encouraged to assess CDS against these recommendations.
- Securities lending and repo:
  - Canada has well-developed securities lending and repo markets that can contribute to settlement.
  - No specific regulatory regime for securities lending and repo markets; they are regulated and supervised by various prudential regulatory bodies.
  - CDS may reconsider introducing a securities lending facility to expedite settlement, as there is room to improve on the level of failed trades in debt instruments.

### Settlement risk (Rec. 6–10)
- Securities custody and transfer:
  - Securities held by most active participants are immobilized.
  - All securities deposited in CDS—both dematerialized and immobilized—are recorded, managed, and transferred through an electronic book-entry system.
  - Ownership transfer occurs when securities are transferred among participants in the books of CDS.
- Delivery-versus-payment (DVP):
  - Achieved through simultaneous transfer of funds and securities when settlement is executed.
  - Funds and securities transfers are final and irrevocable between participants and CDS.
  - End-of-day obligations among CDS and banks acting as cash clearers are settled through the Large Value Transfer System for Canadian dollars and FedWire funds for U.S. dollars.
- Intraday liquidity and credit exposure:
  - CDSX allows participants to have negative funds balances at CDS intra-day.
  - Credit position risk is managed by standby lines of credit provided by participants’ extenders of credit and collateral pools.
  - Through novation, CDS takes on the credit exposure from the time of novation until end-of-day settlement of associated payment obligations.
  - In the event of default, CDS has risk control procedures including full collateralization of exposures that exceed a predetermined limit.
  - Liquidity risk is managed using securities in the collateral pool, participants’ funds, and credit lines from commercial banks.
- Settlement agent concentration:
  - For end-of-day settlement of payment obligations, participants use several commercial banks as settlement agents that make and receive settlement payments to and from CDS’ settlement account at the BoC.
  - For the end-of-day settlement of the cash leg of U.S. dollar-denominated securities, CDS currently uses a single bank.
  - CDS is encouraged to reduce agent bank concentration risk by relying on several banks, or having access to FedWire funds either directly or through the BoC.
- Transparency:
  - CDS practice of taking on credit exposure as a CCP should be more transparent.

### Operational risk (Rec. 11)
- CDS has adequate procedures and processes to monitor, identify, and manage operational risk.
- Operational risk issues are handled by senior managers and checked by the Managing Director.
- Written documentation exists to handle different contingency scenarios.
- A “live” secondary site enables resumption of operations within a short period if the primary site malfunctions.
- Business continuity plan and back-up facilities are subject to internal and external audit.
- Systems are tested on a regular basis and market participants are involved in testing.

### Custody risk (Rec. 12)
- CDS operates an “indirect holding” system: securities are registered in the name of a broker-dealer or custodian (through nominee accounts) rather than the ultimate investor.
- Technical and institutional arrangements are in place to protect customers’ securities:
  - Participants are required to segregate their assets from those of customers.
  - Participants must carry out internal audits regularly to reconcile securities held in their records.
- Adequate accounting practices and safekeeping procedures are in place to protect customers' securities against claims of a custodian's creditors.

### Other issues (Rec. 13–19)
- Governance and transparency:
  - CDS is owned by users; Board of directors reflects interests of shareholders, users, and the public interest.
  - Rules, procedures, fees, and major decisions are published on its external Web site.
  - Market participants noted committee work and board candidate selection may not fully take into account interests of nonbank participants.
- Access and exit:
  - CDS access criteria are objective, permit fair and open access, and are disclosed on the CDS Web site.
  - Foreign participation requires additional regulatory approvals from relevant federal or provincial bodies (e.g., approval by the Governor of the BoC).
  - Procedures for participant exit, whether initiated by participant or CDS, are clearly stated in participant rules.
- Pricing and user assessment:
  - CDS routinely reviews pricing levels against costs of operation.
  - Conducts user surveys and benchmarks costs and charges against other systems to assess user satisfaction.
- Disclosure:
  - CDS rules and contractual arrangements defining participants’ rights and obligations are publicly available.
  - CDS has published the answers to the questionnaire in the CPSS/IOSCO disclosure framework, published its full risk model, and provides an annual update to its report on internal controls.
- Links to foreign systems:
  - CDS has several links to foreign securities settlement systems; most important are links with DTC and the National Securities Clearing Corporation (NSCC).
  - Two of the three links to the United States and a link to the United Kingdom settle against cash; others are free-of-payment.
  - Links to DTC and NSCC expose CDS to potential credit risk and financial losses.
- Regulatory roles:
  - Roles and responsibilities of public authorities are clearly defined and transparent.
  - BoC oversees CDSX at the federal level; OSC and AMF have provincial regulatory responsibility for CDS as a clearing house and depository.
  - Cooperation between authorities is informal and ad-hoc.

### Key CPSS/IOSCO Observations (summary of selected Recommendations)
- Legal risk:
  - CDS design and operations covered by a solid legal basis; contractual arrangements enforceable.
- Pre-settlement risk:
  - Trade confirmation for regulated markets occurs same day between direct participants and next day for indirect participants; OTC convention is same-day confirmation.
  - Settlement cycles: T+3 for equities; T+0, T+2, or T+3 for debt instruments; OTC negotiable but convention follows traded instruments.
  - CDS acts as CCP for cash leg of all transactions and for securities leg in net settlement procedures; however, CCP novation occurs at settlement date for majority of transactions, meaning participants face counterparty risk until novation (up to T+3).
  - No explicit cost-benefit analysis for introducing a CCP for TFT transactions; CDS completed a self-assessment against CPSS/IOSCO Recommendations but its CCP risk management has not yet been formally assessed.
  - CDS does not provide a securities lending facility; CDS analysis suggests no business case exists to develop such a facility; no specific barriers inhibiting securities lending.
- Settlement risk:
  - Majority of Canadian securities are dematerialized or immobilized in CDS; increasing dematerialization would reduce costs and increase efficiency.
  - CDS provides DVP; intraday and end-of-day settlement finality are available.
  - Settlement of cash leg uses commercial bank money during the day, with end-of-day balances settled through BoC accounts; settlement risk for U.S. dollar-denominated securities is concentrated on a single bank.
- Operational, custody, access, disclosure, and oversight:
  - CDS has adequate operational risk measures, contingency planning, and testing.
  - Adequate custody protections (asset segregation, regular reconciliation).
  - Access and exit criteria are publicly disclosed; foreign participants subject to regulatory regime to limit systemic risk.
  - CDS uses a proprietary messaging interface domestically and recognized international standards for cross-border transactions (e.g., SWIFT new messaging formats).
  - CDS has publicly disclosed CPSS/IOSCO questionnaire responses and other materials; oversight by BoC and securities regulators is adequate though cooperation is informal and ad-hoc.

*Source: IMF Financial Sector Assessment content unit _cr0859 - 106.*

### 19. CSDs that establish links to settle cross-border trades

### 19. CSDs that establish links to settle cross-border trades

### Overview and key exposure
- CSDs that establish links to settle cross-border trades should design and operate such links to reduce effectively the risks associated with cross-border settlement.
- The CDS has established links with securities clearing and settlement systems in the United States, United Kingdom, Japan, France, and Sweden as part of their cross-border services.
- The links to the United States markets are the most important ones in terms of features and activities.
- The CDS and its participants are exposed to potential credit and financial risks when using the United States links.
- The CDS permits the delivery of cross-border securities, delivered through the DTC links, before settlement finality is achieved in the DTC system.

### Recommended Action Plan (Table 8) — summary of recommendations and recommended actions
- Pre-settlement risk
  - Recommendation 4: CCP
    - Recommended Action: In order to fully observe this recommendation, the CDS should explicitly assess the benefits and costs of acting as a CCP for TFT transactions.
  - Recommendation 5: Securities lending
    - Recommended Action: The CDS might reconsider introducing a securities lending facility in order to reduce settlement failure.
- Settlement risk
  - Recommendation 9: CSD risk controls
    - (No additional text provided in source.)
  - Recommendation 10: Cash settlement
    - Recommended Actions:
      - In order to further protect the CDSX from the credit and liquidity risks inherited in the CCP services and, as international best practice, the CCP functions should be separated from the settlement and custody functions, with the CCP being provided by a distinct legal entity.
      - For the full observance of this recommendation, the CDS needs to reduce the current concentration of settlement cash for U.S. dollar-dominated securities on a single settlement bank.
      - The CDS might explore the possibility of becoming a direct member of Fedwire or having access to U.S. dollar central bank money through the Bank of Canada.
      - The CDS practice of taking on credit exposure as a CCP should be more transparent.
- Custody risk
  - Recommended Action: In order to reduce custody risk, the CDS should eliminate the circulation of physical securities through its regional offices by immobilizing or, preferably, dematerializing them.
- Other issues
  - Recommendation 13: Governance
    - Recommended Action: The workings of the committees set up by the CDS could be made more transparent, taking into account the interests of nonbank participants.
  - Recommendation 16: Communication procedures
    - Recommended Action: The CDS may wish to adopt a modern messages interface that is more user-friendly.
  - Recommendation 18: Regulation and oversight
    - Recommended Actions:
      - Cooperation between the BoC and the provincial securities regulators should be strengthened and formalized.
      - The same recommendation applies to the cooperation between the Canadian authorities and the relevant United States authorities for the cross-border activities through the links between Canada and the United States.
      - A key objective is to make the regulation and oversight of clearing and settlement activities more effective and transparent for both service providers and market participants.
  - Further Recommendation 19: Cross-border links
    - Recommended Actions:
      - The CDS should not allow the transfer of securities, delivered through the DTC links, to its participants until these securities reach settlement finality in DTC system.
      - The CDS needs to reduce the concentration on a single bank for the settlement of the cash leg in DTC.

### Authorities’ response to the assessment (paragraphs 124–129) — principal responses and actions
- Paragraph 124: CCP (Recommendation 4)
  - The recommended action states that CDS should assess the benefits and costs of acting as a CCP for TFT transactions.
  - Although no explicit cost-benefit analysis was undertaken, the pros and cons of offering CCP for trade for trade transactions were implicitly evaluated as part of the decision to offer the TFT service without a CCP.
  - Regulators intend to raise with CDS, for its consideration, the issue of providing TFT on a CCP basis.
- Paragraph 125: Legal separation of CCP functions (Recommendation 10)
  - The recommended action states that the CCP functions should be legally separated from the custody and settlement functions, in order to protect CDSX from the liquidity and credit risks faced by the CCP.
  - In the context of the recent corporate restructuring, the regulators raised with CDS the issue of having its CCP function in a separate legal entity.
  - However, in light of the controls in place to mitigate the risks faced by CDS as a CCP, regulators were comfortable approving a corporate structure for CDS, which did not legally separate the CCP activities from the depository and settlement activities.
- Paragraph 126: Cash settlement concentration
  - The recommended action states that CDS needs to reduce the current concentration of settlement cash for U.S. dollar-denominated securities on a single settlement bank.
  - The BoC has discussed this issue and potential solutions on several occasions with CDS, including those solutions noted in the FSAP.
  - As a partial response, CDS is considering contracting a second bank to provide U.S. dollar settlement services as a contingency.
  - From the BoC’s perspective, given the relatively small size of the potential financial losses, and the potential efficiency loss and operational risk involved in some solutions, the BoC has accommodated this situation—although the intention is to continue to raise this issue with CDS, seeking possible solutions when warranted.
- Paragraph 127–128: Regulation and oversight cooperation
  - Recommended action: cooperation between the BoC and the provincial securities regulators, and between Canadian and U.S. authorities for cross-border links, should be strengthened and formalized.
  - Current practice: the BoC and the provincial regulators (the OSC and AMF) coordinate on an ad-hoc basis, as needed, with working-level and senior-level interactions.
  - The FSAP discussions concluded that a more regular, formal meeting (for example, annually or semi-annually) of the three regulators would be worthwhile to review CDSX issues from various perspectives; further interaction could be built if useful.
  - BoC staff are preparing a review of the oversight of cross-border clearing and settlement links more generally, recommending regular consultation with relevant foreign regulators; for example, an annual visit with foreign regulators most important to the operation of CDSX.
- Paragraph 129: Cross-border DTC link finality (Recommendation 19)
  - Recommended action: CDS should not allow the transfer of securities, delivered through the DTC links, until these securities reach settlement finality in the DTC system.
  - In DTC, credit entries to a receiver’s securities account are not final until the receiver has paid for them at the end-of-day. If the receiver does not meet its end-of-day settlement obligations to DTC, then DTC can take back the securities credited provisionally to the receiver earlier that day.
  - Finality of settlement can occur during the business day if the receiving party instructs DTC to effect a delivery, pledge, or withdrawal of securities.
  - Whether CDS allows the transfer of securities, delivered through the DTC links, before those securities reach settlement finality in DTC depends on whether instruction by the receiver to deliver the provisionally credited securities to another participant is sufficient for its own received delivery to become final.
  - Determining this requires verification of how DTC rules and law work in the United States on this detail.
  - From an oversight perspective, even if CDS permits such transfers prior to DTC finality, CDS is protected through general risk controls it has in place.
  - If DTC could require replacement of securities imported into CDS (for example, if the CDS-sponsored participant in DTC failed to meet its end-of-day payment obligations), the costs associated with replacing the securities in DTC would be borne by the defaulting participant sponsored into DTC by CDS, and by surviving CDS-sponsored participants, in accordance with established CDS rules.
  - Conclusion: It may or may not be the case that CDS permits the transfer of securities via the DTC links prior to settlement finality in DTC, depending on particular DTC rules and U.S. legal protocol; however, any resulting risk to CDS is sufficiently mitigated.

*Source: _cr0859 - 19. CSDs that establish links to settle cross-border trades*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr0859.pdf_